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    Covered Interest Arbitrage

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    7. Covered Interest Arbitrage (CIA)

    7. Covered Interest Arbitrage (CIA)

    Given the following:

    US 90-day interest rate 5%
    Canadian 90-day interest rate 10%
    Current Spot Rate $0.8512/C$
    90-day Forward Rate $0.8501/C$

    You have $1 Million and would like to engage in CIA:

    i.) Outline the steps for CIA with the appropriate computation there of and compute the profit.

    ii) Compute the Return on Investment of $1 million and identify its components:

    a) Interest Rate Component and
    b) Exchange Gain/Loss Component

    iii) For Interest Rate Parity to prevail, what should be the forward rate of the C$?

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    https://brainmass.com/business/foreign-exchange-rates/covered-interest-arbitrage-148137

    Solution Preview

    7. Covered Interest Arbitrage (CIA)

    Given the following:

    US 90-day interest rate 5%
    Canadian 90-day interest rate 10%
    Current Spot Rate $0.8512/C$
    90-day Forward Rate $0.8501/C$

    You have $1 Million and would like to engage in CIA:

    i.) Outline the steps for CIA with the appropriate computation there of and compute the profit.

    ii) Compute the Return on Investment of $1 million and identify its components:

    a) Interest Rate Component and
    b) Exchange Gain/Loss Component

    iii) For Interest Rate Parity to prevail, what should be the forward rate of the C$?

    iii) For Interest Rate Parity to prevail, what should be the forward rate of the C$?

    For interest rate parity to prevail
    Forward rate / Spot rate = (1+ US interest rate x 90/365) / (1+ Canadian interest rate x 90/365)

    or Forward rate / $ 0.8512 = (1+ 5% x 90/365) / (1+ 10% x 90/365)

    or Forward rate = $0.8410 /C$

    i.) Outline the steps ...

    Solution Summary

    Illustrates the mechanism of Covered Interest Arbitrage.

    $2.19

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